Friday, September 22, 2006



This being an era of utterly failed leadership, total moral bankruptcy, and intellectual dwarfism, Donald Luskin is always in danger of losing his standing as The World's Stupidest Man(®). But as Smartmoney readers know, he is always a contender. Today was a particularly strong showing: THERE'S AN ENDURING modern myth among investors that the economy is about to collapse because consumers are going to stop spending. Like all myths, this one starts with a grain or two of truth, and then embellishes that grain until it's a preposterous mountain. These mythical mountains are dangerous only if you believe them. Lots of my readers do, and so do lots of my professional investor clients. And worst of all, so does the Federal Reserve — which is going to lead to some really bad monetary-policy errors. I'm not sure why consumption is supposed to be so important. Sure, if I've heard it once, I've heard it a thousand times: "The consumer is 70% of the U.S. economy." But so what? The producer is 100% of the U.S. economy. ... What's everyone so worried about? ... According to the Department of Commerce, in July, ... personal-consumption expenditures grew at a very healthy annualized pace of 10.2%. ...What's that in dollars? A lot. From June 2005 to June 2006, the U.S. consumer spent $9.2 trillion dollars — up $555 billion from the previous 12 months. And where did the U.S. consumer get that extra $555 billion to spend? The old-fashioned way — he worked for it. Over that same period, disposable personal income grew by $550 billion.... Economists have studied the "wealth effect" in depth. Based on these studies, most economic models say that when the value of your house goes up by $100, you are willing to spend an additional $3 every year. So how big is the "wealth effect" for housing? According to data from the Federal Reserve, the value of real estate held by households grew by $1.7 trillion over the last four quarters. Three percent of that is $50 billion. ... Since the end of 2002, according to the Department of Commerce, annual energy expenses for the average household have gone up by $688. ...But over the same period, the disposable personal income of the average household has risen by $4,605. That's enough to fill 'er up, with an awful lot left over.... According to the Federal Reserve, since the beginning of 2003, the fraction of the typical household's income that went to servicing mortgage debt did rise a little bit, from 9.7% to 11.1%. But the fraction that went to servicing credit-card debt went down, from 6.3% to 5.7%. Overall, the fraction of household income that goes to servicing all the "must-pay" obligations that every family has — mortgage, credit cards, taxes, and so on — has stayed rock steady, rising almost imperceptibly from 18.4% to just 18.6%.... And how about those adjustable-rate mortgages that will become more expensive to pay off now that interest rates are so much higher than they were a couple years ago? Another myth! The typical U.S. household actually does better when rates rise. Overall, according to the Federal Reserve, U.S. households hold about 50% more floating-rate assets than they have invested in floating-rate debt. So, yes, when rates rise, the adjustable-rate mortgage goes up, and so does the interest on credit-card debt. But at the same time, income rises — even more — from investments in money-market funds, bank accounts and bonds. Even though much of the data I've cited here comes from the Federal Reserve, the Fed subscribes to the myth that the economy is slowing because the U.S. consumer is in trouble... The economy isn't slowing, and the consumer is not in trouble. With the economy continuing to boom, and rates on hold at the Fed, that's a sure-fire formula for more inflation. ... Then there will be nothing for the Fed to do but raise interest rates sky high. It's like one of those How Many Errors Can You Find in this Picture puzzles in the newspaper. It's so bad that I imagine I have violated Fair Use in attempting to quote enough of it to be fair to Luskin, to not turn the mountain of idiocy he has accumulated in one column into an entire continent. I doubt I will get enough time to deconstruct anywhere near the number of errors in this column. But let's start from the most basic: when a little-but-even-so-too-well-known financial analyst calls the Fed and professional investors gullible, there would seem to be a hubris problem. Like ten gallons of self-esteem in a two-ounce jar. His annualization of one month's consumer spending growth figures to come up with a ridiculous number growth rate is a classic. It's like averaging a basketball player's jumping over a game to claim he never touched the ground. I'd like to know what economists he's citing for the "wealth effect" on housing prices. And then there's this little problem of confusing the median and the mean that runs through most of Luskin's writing. So, here's an exercise to our readers: 1. How accurate are his claims about consumer debt? 2. Is he correct that household income has risen much faster than energy costs? 3. Is the economy "continuing to boom"? 4. Does a rise in interest rates benefit a typical household more in increased interest payments or cost it more? 5. How does the latter tie into Luskin's plan for saving the American economy? 6. What does "the producer is 100% of the American economy" mean? I see that DeLong has not commented on Luskin. But he is dealing with a number of powerful contenders for the WSM honor. The World's Stupidest Man (®) is a registered trademark held by Bradford J. DeLong enterprises.
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